Wells Fargo Nicked by Home Equity Loan Defaults

Wells Fargo, which has evaded the subprime mess better than other large banks so far, last week said it will set aside a $1.4 billion loss reserve related to home-equity lending.

Wells Fargo already had tightened underwriting requirements in the aftermath of earlier home-equity losses. Now, the company is "no longer accepting business" through the third-party lending channels responsible for the anticipated fourth-quarter hit.

Wells Fargo said it will no longer originate home-equity loans through wholesalers where the combined loan-to-value ratio of the first and second mortgages is 90% or higher, or where the second mortgage is not behind a Wells Fargo first mortgage.

Wells Fargo also is no longer acquiring home-equity loans through correspondent relationships, including other financial institutions or mortgage companies.

"Given today's uniquely challenging environment, we believe that sharpening our focus on our better-performing and relationship-based home-equity loans is in the best long-term interest of our company," said John Stumpf, Wells Fargo president and CEO, in a statement. He added that Wells Fargo considers home-equity loans remain an important product and that Wells Fargo remains "open for business" in all direct-to-customer channels.

The company also has put $11.9 billion of loans acquired through these indirect channels in "liquidating status" under a dedicated management team. The company said it expects to incur losses totaling about $1 billion over the course of 2008 and 2009 from these loans.

The $11.9 billion liquidating portfolio represents 3% of Wells Fargo's total loan portfolio and are the highest risk segment of Wells Fargo's $83.4 billion home-equity group portfolio, the company said. They represent the most recently originated vintages with the highest combined LTV ratios that are not behind a Wells Fargo first mortgage. In addition, the loans in the liquidating portfolio are concentrated in a few geographic areas with the "most abrupt and steepest declines in housing values," the company said.

Wells Fargo has up to this point avoided the large credit hits related to the subprime meltdown that have stricken some other large mortgage lenders, largely because the company did not originate controversial products such as payment-option ARMs and negative-amortization ARMs. Below certain credit scores, Wells Fargo did not offer stated-income or low-documentation loans.

"Because of our conservatism, we lost market share in the subprime segment the past three years and we're glad we did," said CFO Howard Atkins in the company release.

Some analysts cautioned that Wells Fargo's new $1.4 billion reserve may not be enough to cover all home-equity losses and that the company still has additional consumer credit exposure in other areas.

Sandler O'Neill managing director Scott Siefers said in a report that by taking a hit in the fourth quarter with the reserve, Wells Fargo will not have seen any further impact on its earnings as the reserve is drawn down to cover losses next year.

"The catch is that last night's action only affects about 3% of the entire loan portfolio. The company is still prone to deterioration in the rest, and credit costs could still be elevated in other areas," Sandler O'Neill noted.

Moody's Investors Service maintained a stable outlook on Wells Fargo's credit ratings after the announcement, saying that the home-equity credit problems are manageable in the context of the company's large earnings base and strong capital position.